Pensions for the self-employed

There have been a lot of news stories circulating about the auto enrolment pensions for employers but if you’re a self-employed business owner, have you taken the time to consider your own pension?

Being self-employed means that saving into a pension can be a difficult habit to develop. There are no employer or company contributions and irregular income can make saving difficult. Although there are now a record number of people in the UK who are self-employed – around 4.6 million – only a third of them are currently saving into a pension. [1]

Paul Budgen is the director of business development at NEST (The National Employment Savings Trust) – a scheme which is run on a not-for-profit basis to offer employees and the self-employed a suitable and low-charge pension.

Why save into a pension?

When you own a small business, you may find that retirement planning is one of the last things on your to-do list but with self-employed people not being compelled to save into a pension scheme, you could be at risk of ending up with little retirement income.

Paul explains that the lack of encouragement to save into a pension means that people are less likely to make the decision to start saving, ‘The reforms to workplace pensions introduced by government (known as auto enrolment) are helping many people save for the first time by overcoming this inertia and making saving simple. However the reforms only affected employers so the self-employed weren’t included.’

Currently, over half of self-employed men and over two thirds of self-employed women don’t have any pension savings at all [2]. One of the reasons, as Paul explains, could be due to the lack of understanding of how pensions work, ‘It’s true that people’s understanding of pensions is limited. In 2015 our research found that just 32 per cent of people felt they understood them while 20 per cent agreed that they didn’t really understand pensions.’

Don’t rely on state pensions

If you’re self-employed, you’re entitled to the State Pension in the same way as everyone else. The full basic State Pension is currently set at a maximum of £155.65 per week or (if you retired/are due to retire after April 2016) [3]

The amount of pension that you get depends on your National Insurance Contributions. To get the full amount of state pension (as shown above) you will need 30 qualifying years of National Insurance contributions or credits. If you have less than the 30 years, you’ll get an amount based on the number of years you have paid or been credited with National Insurance.

‘It’s not my place to offer financial advice, but very broadly self-employed people need to think about what sort of retirement they would like. Recent research suggests that millions of people have unrealistic expectations about their retirement income.’ says Paul Budgen.

On its own, the State Pension is unlikely to provide you with anything close to your current standard of living, so it’s important to plan how you will save the rest of the retirement income that you’ll need.

‘Our findings show that most people expect their retirement income to be quite high in relation to their current income, yet most people are not saving enough to match their expectations. I think it’s worrying that many savers seem to have unrealistic expectations about their level of retirement income.’ adds Paul.

The sooner you begin to save, the more time it will give you to contribute towards your fund before retirement and to benefit from tax relief.

What types of pensions are available?

There are a range of pensions that you can set up including personal pensions, stakeholder pensions and self-invested personal pensions (SIPPs). The main differences between the three are the level of charges you have to pay, the flexibility about when and how much you can save and the investment choices available to help grow your pension pot.

Pensions available to anyone who is self-employed are generally provided through insurance companies, banks and financial companies.

Personal Pension

Personal pensions are available to UK residents under the age of 75 and offer a lump sum (you can take out around 25% of your pension tax-free) and regular income during retirement.

The amount that you receive on retirement (generally permitted between the age of 55 and 75) will depend on the amount you saved, your age when you retire and how well your money was invested. Personal pensions generally incur a start up and running charge, which is usually deducted from your fund.

Stakeholder Pension

Like a personal pension plan, a stakeholder plan is also available to UK residents between the ages of 55 and 75. These schemes are worth considering if you have an irregular income.

These standards include flexible contributions starting from £20 per month (sometimes less), a charging structure capped at 1.5% of the fund each year for the first 10 years and 1% thereafter and no penalties for increasing, decreasing, stopping, restarting or transferring your pension.

Self-invested personal pension plan (SIPP)

A SIPP generally follows the same basic rules as the above regarding contributions, tax relief and eligibility. The main difference is in the investment freedom that a member has and the ability to borrow against the fund to make further investments.

A SIPP allows plan holders to have a much wider choice of investment options for their pension money, meaning that they can have complete control over where their money goes and how it is invested to grow. Plan holders can also appoint fund managers or stockbrokers to manage their investments.

Tip: You should only consider a SIPP if you are experienced in investing and are comfortable in making your own decisions.

What are the rules for paying into a pension?

You can save as much or as little as you like towards your pension each year. Pension payments are made over 12 month periods called ‘pension input periods’ or PIPs. From April this year, pension payments will follow the financial year (6th April to 5th April).

Tax relief rules

Tax relief means that some of the money you may have paid as a tax to the government goes into your pension instead. If you are saving into a pension, you are entitled to a certain amount of income relief.

Generally, if you are a UK taxpayer, for the year 2016-17 the standard rule is that you’ll get tax relief on pension contributions up to 100% of your earnings or £40,000 annual allowance – whichever is lower.*

For example if you earn £20,000 per year but put £25,000 into your pension pot, you will only get tax relief on £20,000 as this is your full annual wage. Similarly, if you earn £60,000 a year and put this all into your pension pot, you will only get tax relief on £40,000 of that total.

*This figure applies to those taking a salary of under £100,000

Where can I get further information on personal pensions?

There are a number of websites and advice services that you can use for additional information about pensions for the self-employed and any other pension queries. A few examples include:

Please note that pension schemes and the rules around them may vary depending on providers. It is advisable that you seek advice when considering which pension scheme is best for you. We have used the best endeavours to ensure the accuracy and completeness of the content but this does not constitute professional advice and must not be relied upon as such.

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